1. Financial Merchandise Management
Chapter 16
Financial Merchandise Management
Dr. Pointer’s Notes

2. Chapter Objectives
To describe the major aspects of financial merchandise planning and management
To explain the cost and retail methods of accounting
To study the merchandise forecasting and budgeting process
To examine alternative methods of inventory unit control
To integrate dollar and unit merchandising control concepts

3. Financial Merchandise Management
With Financial Merchandise Mgmt, a retailer specifies which products are purchased, when products are purchased, and how many products are purchased
Dollar control involves planning and monitoring a retailer’s financial investment in merchandise over a stated period
Unit control relates to the quantities of merchandise a retailer handles during a stated period

4. Benefits of Financial Merchandise Plans
The value and amount of inventory in each department and/or store unit during a given period are delineated
The amount of merchandise a buyer can purchase during a given period is stipulated
The inventory investment in relation to planned and actual revenues is studied
The retailer’s space requirements are partly determined by estimating beginning-of-month and end-of-month inventory levels

5. Benefits of Financial Merchandise Plans_2
A buyer’s performance is rated. Measures may be used to set standards
Stock shortages are determined and bookkeeping errors and pilferage are uncovered
Slow-moving items are classified – leading to increased sales efforts or markdowns
A proper balance between inventory and out-of-stock conditions is maintained

6. Inventory Valuation: The cost and retail methods of accounting
There is a need to develop a retail inventory accounting system
Retailers have different data needs than manufacturers, cost estimation is more difficult, stock shortages higher, sales more frequent and they require monthly not quarterly profit data
Two inventory accounting systems are available

7. Inventory Valuation: The cost and retail methods of accounting
Dollar control system provides data on sales and purchases, value of beginning and ending inventory, markup and markdowns and merchandise shortages.
Merchandise available for sale = beginning inventory, purchases and transportation charges
Cost of goods sold = cost merchandise available minus cost value of ending inventory
Gross profits = sales less cost of goods sold
Net profit = gross profits – operating expenses

8. Table 16.1 Handy Hardware Store Profit-and-Loss Statement
Sales
$417,460
Less cost of goods sold:
$ 44,620
Beginning inventory (at cost)
289,400
Purchases (at cost)
2,600
Transportation charges
$336,620
Merchandise available for sale
90,500
Ending inventory (at cost)
$246,120
Cost of goods sold
$171,340
Gross profit
Less operating expenses:
Salaries
$ 70,000
Advertising
25,000
Rental
16,000
Other
26,000
Total operating expenses
137,000
Net profit before taxes
$ 34,340

9. Inventory Accounting Systems
1. The cost accounting system values merchandise at cost plus inbound transportation charges
2. The retail accounting system values merchandise at current retail prices

10. Cost Method of Accounting
The cost to the retailer of each item is recorded on an accounting sheet and/or is coded on a price tag or merchandise container
Can be used with physical or book inventories:
Physical inventory – actual merchandise is counted at closed of a specified period of time
Book( perpetual) inventory – keeps a running total of the value of all inventory on hand at cost based on records. No need for actual counting of stock. Frequent financial statements can be prepared.

11. Physical Inventory System
Ending inventory - recorded at cost – is measured by counting the merchandise in stock at the close of a selling period
Gross profit is not computed until ending inventory is valued
Gross profit derived during full merchandise count

12. Book Inventory System
Keeps a running total of the value of all inventory on hand at cost at a given time
End-of-month inventory values can be computed without a physical inventory
Frequent financial statements can be prepared

13. Book Inventory System _2
Types of book inventories
FIFO- logically assumes all old merchandise is sold first. Most reasonable but results in higher taxes
LIFO – assumes new merchandise is sold first. Results in lower profits and lower taxes and understated ending inventory
Both are acceptable ways to value merchandise

14. Disadvantages of Cost-Based Inventory Systems
Requires that a cost be assigned to each item in stock
Do not adjust inventory values to reflect style changes, end-of-season markdowns, or sudden surges of demand
Works best for retailers low inventory turnover, limited assortment and high average prices (car dealers)

15. Table 16.2 Handy Hardware Store Perpetual Inventory System
Date
Beginning-of-Month Inventory
Net Monthly Purchases
Monthly Sales
End-of-Month Inventory
7/1/03
$90,500
$40,000
$ 62,400
$68,100
8/1/03
68,100
28,000
38,400
57,700
9/1/03
27,600
28,800
56,500
10/1/03
44,000
71,700
11/1/03
50,400
40,800
81,300
12/1/03
15,900
61,200
36,000
TOTAL
$205,900
$260,400
(as of 12/31/03)

16. The Retail Method
Closing inventory is determined by calculating the average relationship between the cost and retail values of merchandise available for sale during a period

17. Determining Ending Inventory Value
1. Calculating the cost complement
Cost Total Cost valuation
Complement = Total retail valuation
$299,892/496,126 = therefore, .60 of every retail sale went cover costs (Table 16.3)
2. Calculating deductions from retail value
Table 16.4 shows ending value of $59,552
3. Converting retail inventory value to cost
$56, 470 X = $34,136
(Ending Inventory value at cost) This can be used to find gross profit.

18. Table 16.3 Handy Hardware Store, Calculating Merchandise Available for Sale at Cost and at Retail
Beginning Inventory
$ 90,500
$139,200
Net Purchases
205,900
340,526
Additional Markups __
16,400
Transportation Charges
3,492
Total Merchandise Available
$299,892
$496,126

19. Table 16.4 Handy Hardware Store, Computing Ending Retail Book Value
Merchandise available for sale (at retail)
$496,126
Less deductions:
Sales
$422,540
Markdowns
11,634
Employee discounts
2,400
Total deductions
436,574
Ending retail book value of inventory
$ 59,552

20. Table 16.5 Handy Hardware Store, Computing Stock Shortages and Adjusting Retail Book Value
Ending retail book value of inventory
$ 59,552
Physical inventory (at retail)
56,470
Stock shortages (at retail)
3,082
Adjusted ending retail book value of inventory
$ 56,470

21. Table 16.6 Handy Hardware Store, Profit-and-Loss Statement
Sales
$422,540
Less cost of goods sold:
Total merchandise available for sale
$299,892
Adjusted ending inventory
34,136
Cost of goods sold
$265,756
Gross profit
$156,784
Less operating expenses:
Salaries
$ 70,000
Advertising
25,000
Rental
16,000
Other
28,000
Total operating expenses
139,000
Net profit before taxes
$ 17,784

22. Advantages of the Retail Method
Valuation errors are reduced when conducting a physical inventory since merchandise value is recorded at retail and costs do not have to be decoded
Because the process is simpler, a physical inventory can be completed more often
Profit-and-loss statement can be based on book inventory
Method gives an estimate of inventory throughout the year and is accepted in insurance claims

23. Limitations of the Retail Method
Bookkeeping burden of recording data
Ending book inventory figures correctly computed only if the following are accurate:
Value of beginning inventory
Purchases
Shipping charges
Markups
Markdowns
Employee discounts
Transfers
Returns
Sales
Cost complement is an average based on the total cost of merchandise available for sale and total retail value

24. Merchandise forecasting and Budgeting: Dollar Control
Dollar control entails planning and monitoring a firm’s inventory investment over time to ensure profitable operations
The six steps involved in the process are outlined

25. Figure 16.2 The Merchandise Forecasting and Budgeting Process: Dollar Control
Inventory
level planning
Designing
control units
Sales
Forecasting
Planning
profit margins
Planning
Purchases
Reduction
Planning

26. Merchandise forecasting and Budgeting: Dollar Control
Control Units –merchandise categories for which data are gathered. Categories is the broadest control units (women’s shoes, men’s suits)
Classification merchandising – each department is sub divided into further categories women’s shoes and dress shoes and casual shoes
Standard classification – recognized classification by trade association and industry.-

27. Merchandise forecasting and Budgeting: Dollar Control
Forecasting – estimating revenues (companywide, departmental or categories). Yearly sales can be broken down by months.
Monthly sales index, divides ach month’s actual sales by average monthly sales and multiples by 100.
Index allows a retailer to project sales by month

28. Table 16.7 Handy Hardware Store, A Simple Sales Forecast Using Product Control Units
Actual Sales 2003 ($)
Projected Growth/ Decline (%)
Sales Forecast 2004 ($)
Lawn movers/ snow blowers
200,000
+10.0
220,000
Paint and supplies
128,000
+ 3.0
131,840
Hardware supplies
108,000
+8.0
116,640
Plumbing supplies
88,000
-4.0
84,480
Power tools
+6.0
93,280
Garden supplies/ chemicals
68,000
+4.0
70,720
Housewares
48,000
-6.0
45,120
Electrical supplies
40,000
41,600
Ladders
36,000
38,160
Hand tools
+9.0
39,240
Total year
840,000
+4.9
881,080

29. Table 16.8 Handy Hardware Store, 2003 Sales by Month
Monthly Actual Sales ($)
Sales Index
January
46,800 67
February
40,864 58
March
48,000 69
April
65,600 94
May
112,196
160
June
103,800
148
July
104,560
149
August
62,800 90
September
46,904
October
November
66,884 96
December
94,792
135
Total yearly sales
840,000
Average monthly sales
70,000
Average monthly index
100

30. Table 16.9 Handy Hardware Store, 2004 Sales Forecast by Month
Actual Sales 2003 ($)
Monthly Sales Index
Monthly Sales Forecast 2004
January
46,800 67
73,423 * .67 = 49,193
February
40,864 58
73,423 * .58 = 42,585
March
48,000 69
73,423 * .69 = 50,662
April
6,600 94
73,423 * .94 = 69,018
May
112,196
160
73,423 * 1.60 = 117,477
June
103,800
148
73,423 * 1.48 = 108,666
July
104,560
149
73,423 * 1.49 = 109,400
August
62,800 90
73,423 * .90 = 66,081
September
46,904
October
November
66,884 96
73,423 * .96 = 70,486
December
94,792
135
73,423 * 1.35 = 99,121
Total Sales
840,000
Total sales forecast
881,080
Average monthly sales
70,000
Average monthly forecast
73,423

31. Merchandise forecasting and Budgeting: Dollar Control
Inventory –Level Planning- need to have sufficient inventory to meet sales
Basic Stock Method - carries more inventory than you expect to sales
Beg month inventory = planned sales + basic stock
Percentage variation method
Weeks Supply Method
Stock to sale method – maintain a specified ratin of goods on hand to sales ( 1.3 ratio means sales of $69K mean inventory of $89K)

32. Merchandise forecasting and Budgeting: Dollar Control
Reduction Planning – retail reduction is the difference between beginning inventory plus purchases , sales plus ending inventory
Planned Purchases =sales for month= planned reductions + planned end of month stock – beginning of month stock

33. Merchandise forecasting and Budgeting: Dollar Control
Planning profit margins – Determines the average markup needed to reach the projected profits
Required initial markup = planned expenses +planned profits + planned reductions/planned net sales + planned reductions

34. Unit Control Systems
Deals with quantities of merchandise in units rather than in dollars. Information will reveal- best selling items,identify problems and opportunities, optimal time to reorder, book inventory, old merchandise, alternative sources for goods and level of sales of each item in every branch

35. Unit Control Systems
Physical Inventory Systems -counts number of units by item classification
Perpetual Inventory Systems - keepings running total of inventory based on sales and purchases, returns, transfers and other transactions
94% of retailers engage in physical inventory systems
57% of retailers use cost inventory systems
68% of retailers use a perpetual inventory system

36. Financial Control: Integrating Dollar ad Unit concepts
Stock Turnover – number of times during a specific period, usually a yr, that the average inventory on hand is sold.
Computation of stock turnover
stock turnover = # of units sold during year
units average inventory on hand
Annual stock = net yearly sales
Turnover $ average inventory on hand

37. Stock Turnover Average stock turnover will vary by industry
Normally want to have high stock turnover
High stock turnover is usually a sign of success
Gross Margin Return on investment (GMROI) shows relationship between the gross margins in dollars and the average inventory investment by combining profitability anal sales to stock measures
good indicator of managers performance

38. When to Reorder
Reorder point – set stock levels at which new orders must be placed
Order lead time- period from the date an order is placed by a retailer to the date merchandise is ready for sale (received, price marked and put on selling floor)
Usage rates –average sales per day, in units of merchandises
Safety stock-the extra inventory that protects against out of stock conditions due to unexpected demand and delays in delivery
reorder pt = usage rate X lead time
Reorder pt + usage rate X lead time + safety stock
Automatic reordering systems – mechanically activated when stock on hand reaches the reorder point

39. Figure 16.6a How Stockouts May Occur
Unexpected Demand
Delayed Delivery

40. How Much to Reorder
Economic Order quantity (EOQ) is the quantity per order that minimizes total inventory costs of processing orders and holding inventory.
EOQ=
EOQ= quantity per order
D= annual demand
S= costs to place an order
I= % of yearly carrying cost to unit cost
C= unit cost of an item
2DS IC

41. Questions
Please read this chapter carefully